The Hindu Business Line : Divided over depreciation

THE Kelkar Task Force Report, submitted in December 2002, called for the removal of all exemption and incentive provisions from the tax law. Yet, the latest Finance Bill provides further incentives by way of additional depreciation, tax holiday for the agro-processing industry, tax benefit under Section 80I(a) for renovation and modernisation of transmission and distribution lines in the power sector, tax holiday for housing projects, and so on.

In July 2004, the Kelkar Task Force submitted another report with a view to streamline the law so that the targets set under the Fiscal Responsibility and Budget Management Act, 2002, may be achieved. In this report, Dr Vijay Kelkar suggested the lowering of the general depreciation rate for plant and machinery to 15 per cent. He also visualised the harmonisation of the depreciation rates under the I-T law and the company law. Such harmonisation would obviate the need for MAT.

The Finance No. 2 Bill 2004 completely ignores the current debate about incentives and depreciation. It provides for additional depreciation of 15 per cent on new plant and machinery acquired and installed on or after April 1, 2005. Under the existing provisions of clause (iia) of sub-section (1) of Section 32, as introduced by the Finance Act, 2002, additional depreciation at the rate of 15 per cent is allowable on new plant and machinery acquired and installed on or after April 1, 2002. This deduction is available to:

a new industrial undertaking in the previous year in which it begins manufacture or production; and

an existing undertaking in the previous year in which it achieves 25 per cent increase in installed capacity.

"Installed capacity" has been defined to mean the capacity of production as existing on March 31, 2002.

To give a thrust to investment in the manufacturing sector, it is proposed to reduce the limit for increase in installed capacity from 25 per cent to 10 per cent.

This amendment will take effect from April 1, 2005, and will, accordingly, apply in relation to the assessment year 2005-06 and subsequent years.

There can be two views on the concept of depreciation itself. One is that the replacement cost would not be at the historical value now prevailing under the income-tax law. Corporate houses will argue that the concept of WDV under the I-T law is antediluvian. But then, one has to consider the fact that companies show inflated profits by claiming depreciation under company law.

It is this dichotomy that led to the introduction of MAT. But corporate houses have a point. Science and technology, though advancing fast, has a high obsolescence rate. And it can be argued that in respect of certain assets forming part of R&D, obsolescence can as high as 100 per cent. It is difficult to reconcile these points.

Two working groups that went into the redrafting of the company and the income-tax laws were not able to agree on the alignment of the depreciation rates.

In this context, the Kelkar Task Force observed thus:

"The Income-Tax Act read with the Income-Tax Rules classifies capital assets into a basket of different assets and provides different percentage rates of depreciation for such basket (known as a block of assets). The depreciable amount is determined on the declining-balance method.

The general rate of depreciation for plant and machinery under the tax law is 25 per cent. This was first prescribed in 1991-92. Such high rate of depreciation was justified in 1991-92 because of the high corporate tax rate of 51.75 per cent, which adversely affected internal accrual of resources for replacement and modernisation.

Consequent to our recommendation to reduce the corporate tax rate to 30 per cent from the existing levels of 36.75 per cent, it is now necessary to review the general rate of depreciation for plant and machinery.

"We recommend that the general rate of depreciation for plant and machinery should be reduced to 15 per cent from the existing level of 25 per cent. We also recommend that the rates of depreciation for other blocks of assets must be reviewed along the above lines."

The Finance Bills of 2003 and 2004 have ignored this vital recommendation. While the debate over depreciation rates can go on and on, the rates have to be in tandem with the current rates of inflation and interest rates.

The economic life of capital assets is measured not by the length of the productive value but by the time it takes for the next generation of technology to come into the market. The current tax regime is biased in favour of capital intensity. Similar encouragement should be given to labour incentive schemes as well.

(The author is a former chief commissioner of income-tax.)